By Drew O’Neil
When it comes to investing, it is important to live in the present. While it may be fun to reminisce about the good ole days, this is generally not helpful when it comes to making investment decisions. For example, it is natural for an investor who first started following the markets in 1991 when the 10-year Treasury was 8% to view this as a normal level, and subsequently view any yield lower than that too low, or higher than that a great opportunity. This is referred to in psychology as an anchoring bias, meaning that your mind is “anchored” to that value and uses it as a benchmark. When making the decision as to what to invest in and when to invest, investors are oftentimes letting these mental anchors guide their decisions.
This is especially true (and potentially very harmful) in the fixed income universe. When faced with allocating to fixed income, many investors are either choosing to let those dollars remain in cash (until yields increase back to what the investor considers a normal level) or allocating “fixed income dollars” to other asset classes as a fixed income substitute. The prudent thing to do instead of waiting or shifting asset classes, is to realize that the past is past and just because yields used to be higher, doesn’t mean that they will return to those levels, or even that those levels were “normal”. It is important to remember that each asset class has its purpose in a portfolio. Fixed income is meant to be the stable ballast that a portfolio is structured around, focused on consistent income, cash flow, and return of principal; something that fixed income substitutes cannot replicate.
A prudent investor will look around at the current landscape and assess where the best current value is and determine how to best take advantage of the current situation to help reach one’s long-term goals. Instead of waiting and trying to predict when yields will return back to desired levels, investors should be asking more useful questions. Taxable bonds or municipals? Where on the yield curve should I position? What are my liquidity needs? What is my risk tolerance? What is the long-term goal for my portfolio? Answering these questions is going to be much more helpful than spending your brainpower wishing things were like the good ole days.
Every investor is going to have a different “anchor” for interest rates. This is commonly tied to some point in the past that your mind has anchored to, but could also be linked to what “experts” claim a normal level for interest rates is. Regardless of the source of the anchor, investment decisions will likely be better served cutting the line and allowing yourself to drift with the current tide rather than be stuck to an anchor that was dropped long ago.
To learn more about the risks and rewards of investing in fixed income, please access the Securities Industry and Financial Markets Association’s “Learn More” section of investinginbonds.com, FINRA’s “Smart Bond Investing” section of finra.org, and the Municipal Securities Rulemaking Board’s (MSRB) Electronic Municipal Market Access System (EMMA) “Education Center” section of emma.msrb.org.
The author of this material is a Trader in the Fixed Income Department of Raymond James & Associates (RJA), and is not an Analyst. Any opinions expressed may differ from opinions expressed by other departments of RJA, including our Equity Research Department, and are subject to change without notice. The data and information contained herein was obtained from sources considered to be reliable, but RJA does not guarantee its accuracy and/or completeness. Neither the information nor any opinions expressed constitute a solicitation for the purchase or sale of any security referred to herein. This material may include analysis of sectors, securities and/or derivatives that RJA may have positions, long or short, held proprietarily. RJA or its affiliates may execute transactions which may not be consistent with the report’s conclusions. RJA may also have performed investment banking services for the issuers of such securities. Investors should discuss the risks inherent in bonds with their Raymond James Financial Advisor. Risks include, but are not limited to, changes in interest rates, liquidity, credit quality, volatility, and duration. Past performance is no assurance of future results.